VAT and National Insurance
When thinking about becoming a freelancer it can be quite daunting knowing that you need to ensure you pay your tax and National Insurance contributions on time. However it really is simple and easy to do.
As soon as you decide to set up a freelance business, whether full or part-time, you need to let HMRC know by completing the relevant CWF1 form, and they will send you a quarterly bill for what is known as ‘Class 2’ National Insurance. This is a basic payment which ensures that you pay enough to cover your future state pension requirements. All additional National Insurance payments (Class 4) are calculated by your accountant when your end-of-year figures are completed, and the amount owed is included in your tax bill.
If you have income from more than one job i.e. you are freelancing whilst still in permanent employment you should take care to ensure you are not paying more in National Insurance contributions than you need to! If you think you may be exceeding the upper limit then you can apply for deferment of contributions.
You do not have to register for VAT unless you hit the VAT threshold, which is currently £81,000 (2015). You must register for VAT when your turnover rises above the threshold in the previous 12 rolling months, or if you expect it to do so in the next 30 days. You have to start keeping records and charging VAT to your customers from the date of registration, which is usually the month after your annual turnover exceeded the threshold.
What are the advantages of being VAT registered?
Even if below the threshold, many people choose to register for VAT to give their business more ‘kudos’ with customers, or simply to make it appear larger than it really is – and this is entirely up to you.
If you do choose to register for VAT then there is the advantage of being able to claim the VAT back on everything you purchase for the business, but the ultimate benefit of this will depend on the type of business you have. If you buy things in and sell them on as part of your business function then it will be an advantage, but if you just charge for your services and only buy things like stationery which are required to run the business, it will be less beneficial.
What about the Flat Rate VAT scheme?
Instead of registering for the standard VAT scheme (outlined above), it may be more beneficial for you to register for the Flat Rate VAT scheme.
Within this scheme, you charge your clients at the standard rate and pay the government at a lower rate of the gross amount. Different sectors have different rates (call us to find out what rate you might be in).
Find below an example for an IT professional whose flat rate is 12% in their first year (new companies get a 1% first year discount):
The VAT percentage you pay is considerably lower than that of the standard VAT rate,(see below table for a full list of the standard rates depending on your profession) you than keep the difference as your profit. See example below based on a Limited Company specialising in IT:
|Net amount you invoice your client||£5,000|
|VAT charged on top to your client (20%)||£1,000|
|Flat rate VAT 13.5% (this includes a first year discount of 1%)||13.5%|
|VAT to be paid to HMRC - 13.5% of £6,000||£810|
|VAT received from client||£1,000|
|Profit for you i.e. what you get to keep||£190|
You’ll need to speak to an accountant before you decide which scheme is best for you. They’ll be able to work out the most tax efficient way to pay VAT.
The reason for this is that the Flat Rate scheme simplifies VAT administration for HMRC and so the financial benefit is passed on, to a point. The rate you pay will vary depending on your business type and when you register for VAT this will be assessed and agreed up front.
You might also like to read the following:
If you wish to find out more about freelancing as a sole trader then you may also be interested in the following pages:
- Benefits of Freelancing - the benefits to you as a freelancer and to your potential clients
- Sole Trader or Limited? - which route is right for you?
- Freelancer Take -home Pay Calculator - how much more could you earn by going freelancing?
- Finding Freelance Work - how to find your freelance roles
- Freelancer FAQ’s- all your questions answered
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